I follow Venoco Inc. on an irregular basis. The company has a huge acreage position in the Monterey shale oil play in California where oil companies haven’t fully figured out how to develop it economically.

If someone does crack the code on this play however, Venoco is likely a home run.

Like virtually every small oil company, Venoco has had its stock price punished over the past several months. The stock which was as high as $22.46 earlier in the year is now all the way down to $7.50.

The Monterey Shale

The Monterey is not a new play, in fact far from it. The major oil companies have produced from the Monterey heavy oil pools since the 1900s. Most of the acreage in the Monterey in California has long been controlled by the major oil companies. This has meant that the smaller independents have not had much of a presence.

What not having that independent presence has likely done is delay the application of new technologies to the Monterey shale. The shale is the zone much deeper than where the majors have produced from conventionally. The majors have been slow to embrace the unconventional oil and gas revolution which has been led by independent producers like Chesapeake and XTO.

The Monterey Shale Play is enormous. The EIA estimated in its report the following numbers with respect to technically recoverable reserves:

The Bakken: 3.6 billion barrels

The Eagle Ford: 3.4 billion barrels

The Monterey: 15.4 billion barrels

How is that you say? More than four times the size of the Bakken.

Don’t get too excited. So far, drilling results being reported by the two main land holders Occidental Petroleum Corp. (OXY) and Venoco are mixed. So this is going to take some more time. But the Bakken was exactly the same. We always knew the oil was there, and through trial and error over a five year period the industry figured it out. The first few wells were disastrous, but a necessary part of the learning process.

I think the industry likely will figure out the Monterey as well.

Venoco

Over the past five years Venoco has been busily identifying and then leasing prospective Monterey acreage. The best way to get a land position in a resource play is before anyone else wants it and it is still cheap. In total Venoco has amassed 214,000 acres with their leasing activity starting way back in 2006.

The potential amount of oil recoverable from this acreage is described by Venoco as being multi-hundred million barrels. If you use a rule of thumb of $20 per barrel in the ground and assume 200 million barrels recoverable the amount of value could easily be several billion dollars. With an enterprise value that today isn’t much over $1 billion the Monterey could clearly turn Venoco into a multi-bagger.

But as an investor you can’t just take a flier on the Monterey, you need some downside protection for your investment. And Venoco does offer that as it has other assets in the Sacramento Basin, Southern California and Texas. In total the numbers on these non-Monterey properties are:

18,000 barrels of oil equivalent of production in H1 2011

Year end 2010 85.1 million BOE of proved reserves

Year end 2010 PV10 reserve value of $1.1 billion

Year end 2010 PV10 reserve value using strip pricing of $1.6 billion

To simplify, the existing booked reserves have a present value using 5 year strip pricing of $1.6 billion which is more than the current enterprise value of Venoco which is just over $1.1 billion. That basically means that all of that Monterey upside, which could be a few hundred million barrels of recoverable oil is being valued at zero by the stock market. That is clearly interesting, although there is reason for caution.

If you have a look at Venoco today, one thing that you shouldn’t be too fussed on is the company debt level. The company currently has a debt to EBITA ratio of about 2.6 to 1. Venoco plans next year to sell its Hastings Texas field (which has no booked reserves but considerable value) and get this ratio closer to 1 to 1. The Hastings field currently has no booked reserves because it is currently not producing. Also in the Hastings field is a Denbury Resources initiated CO2 flooding project in December 2010. When that production recommences interest in the Venoco position in the field should increase and a deal to reduce Venoco’s debt transpire.

A “Take-Under” Bid That is Starting to Look Pretty Good

On August 29, 2011 Venoco’s CEO made this offer to shareholders of the company:

“I am pleased to offer to acquire all of the outstanding shares of the common stock of Venoco, Inc. (the “Company”) at a cash purchase price of $12.50 per share. I believe that this offer is fair and in the best interest of the Company and its public shareholders and that the shareholders will find the proposal attractive. The offer represents a premium of 39% over the Company’s most recent closing stock price on August 26, 2011 and a 27% premium to the average closing price in August 2011.”

That premium is now 66%.

At the time I thought this bid was pretty questionable as I was about a week removed from listening to the CEO present at the Enercom conference where he explained that he thought the company was worth over $20.

And I thought it was especially questionable because if you exclude the darkest hours of the financial panic from October 2008 through June 2009, you will notice that Venoco’s share price has always been over $15. Heck, even near the end of July 2011 the share price was $15 per share.

At the time, CEO Marquez made his offer the share price had been under his offer price for the grand total of two weeks. This offer seemed to me to be a clear attempt to swoop the company out from under his long term loyal shareholders who most definitely have average cost bases far in excess of the offer price.

Now, however, with the share price at $7.50 and the world a much scarier looking place than it seemed just a month ago, that $12.50 offer must look pretty enticing — especially for shareholders who know there are plenty of opportunities out there to redeploy proceeds into.

Summary

- Venoco has conventional assets that more than support the current share price

- If the Monterey shale pans out Venoco has multi-bagger upside

- All of this might not matter as the CEO may end up with the company at a 66% premium to today’s price

- If the CEO deal does fall through, you are left with a company that does have a lot of debt in a world where debt is once again perceived as frightening and could very well be problematic if commodity prices plunge for an extended period

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